k uwait t urk investment banking and sukuk : an introduction to islamic capital markets

KUWAIT TURK INVESTMENT BANKING AND SUKUK : An Introduction to Islamic Capital Markets

İSTANBUL

21 October 2011

REŞİD ÇİZMECİInvestment BankingKuwait Turkish Participation Bank

KT Investment Banking Department

Functions

Utilization of Non-domestic Funds (e.g. Bahrain Branch, ITFC, SEP)

Sharia compliant Debt Financing(e.g. Sukuk, Subordinated Loans)

Project Finance

Supervision of Corporate Branches

Agenda

Islamic Capital Markets : A Brief History

Sukuk : A Milestone in Islamic Banking

Sukuk Market : An Update

Sukuk : Issuers’ Perspective

Sukuk Structures and Secondary Market Practice

Case Study : Turkish Experience

Key Considerations & Future of Sukuk

Q&A

Increasing market presence

Islamic Banking : From niche to critical mass

− Growing at 15 to 20% per annum− Size estimated more than SD 1 trillion globally

− New markets welcoming Islamic banks and products

Market-driven proposition − Retail demand has historically the backbone of the industry− Sensitivities to principles more visible on retail deposit − But corporates and even sovereigns showed appetite for the products− Market-driven product development proved to be successful− Self-regulating organisations accompanied global Islamic banking boom

Global scale

− More than 250 Islamic banks worldwide operating in over 75 countries − A wide range of interest varying from U.K. to Singapore− Widening customer base including sovereigns to top global corporates

to tap Islamic finance markets

Singapore: Active in developing Islamic finance

Germany: Kuwait Turk received licence for a branchSaxony issues E100m Sukuk (2004)

UK: Five active IslamicbanksSukuk on its way

Kuwait & UAE: Hub for Islamic banking

Malaysia: Islamic product and industry, development and sophistication leader

China: Active member of IslamicFinancial Services Board (2004)

Bahrain: Leading Islamic financial centre, and housing regulatory bodies

Saudi Arabia: 95%+ of new consumer lending is Islamic • Retail market rapidly

converting to Islamic

…with worldwide momentum

Each region is contributing in a unique way

Japan: JBIC exploring Islamic financing opportunities

Turkey: 25 years of Islamic banking experience

Russia: Increasing interest

France : Recent declaration of Islamic Banking interest

Industry has developed a comprehensive product offering over its young history

1950s

60s

70s

80s

90s

2000s

− First institutions emerged to test the market

− Development of theoretical framework− First attempts to structure Islamic banking

products

− Islamic Development Bank (1974) and DIB− One country-one bank setup

− Advancement of Islamic products− Turkish market to welcome Islamic banking− Full “Islamization” of banking in some

countries (Pakistan, Sudan etc.)

− Entry of global institutions & Islamic windows− İncreasing global coverage of Islamic banking

− Islamic banks achieving strong and stable growth globally,

− New products in international markets− Sukuk market to boom

1970s

Insurance

1980s Syndications

Structuredand trade financeEquity

Private equity

Projectfinance

Capital markets / structured products

1970s

1980s

Evolving richness in productsDevelopment of industry

Industry has near like-for-like parity with conventional offering

New capital market instruments introduced in the last decade

Commercialbanking

1990s

2000s

Islamic banking

75 %

Sukuk18 %

Equity funds2%

Mutual funds4%

Takaful1 %

Global Deployment of Islamic Products

Mainstream relevance

Engaging with regulators

Breakdown of Islamic Banking Principles Compliant Assets

Worldwide (2010)

Source: KFHR Global Islamic Finance Directory

Islamic banking86.9%

Sukuk7.0%

Equity funds2.5%

Mutual funds3.5%

Takaful0.1%

Breakdown of Islamic Banking Principles Compliant Assets

Worldwide (2003)

Niche presence Conceptual exploration

Components of ICM

• A forum for investors to invest in the shares of the companies • An opportunity to share the profit of the company• Compliance of operations to Shariah Principles

• Islamic equivalent of a conventional bond• Asset-based investments as the investor in Sukuk owns an undivided interest in

underlying asset• The Sukuk certificate is evidence of this ownership

• Aimed to manage financial risk compliant with Shariah Principles• Many forms of Islamic hedging instruments have been established and offered• Some products such as capital protected funds, equity linked notes, Islamic

options, Islamic forward forex, and Islamic profit rate swap

The industry has not yet reached its potential

Still new markets exist that did not yet meet with Islamic banking and finance

The global Islamic insurance (Takaful) market is estimated to expand

Most Islamic financial institutions are highly liquid, and seek new asset classes and markets to diversify

– New treasury products and investment securities are to emerge

– Capital markets developments: New Sukuk issuances expected to tap the market

Islamic finance has also gained popularity in Muslim-minority countries

– Germany issued the first Islamic Eurobond (2004)

– Five Islamic banks in UK

Trends of convergence and conversion– Islamic banks introducing new products and services to compete with the conventional

banks,

– Conventional banks aiming to tap Islamic banking markets and expand their product base

Strong growth of GCC economies

Retail customer commitment

Development ofIslamic capital markets

Liberalisation of capital markets

Innovative product development

Market developments urging countries and customers

to diversification

EXPLOSIVE GROWTH OF ISLAMIC FINANCE

Industry is driven by fundamental factors

Why Islamic financing is flourishing

Tested strength in the financial crisis

Islamic banking, a booming $US1 trillion global industry that prohibits speculation and high levels of debt, has been relatively unscathed by the credit crunch.

Islamic banking model’s basic principles of

– Financing “real” trade and economic activities,

– No financing of speculation

– No engagement in debt trading

– Asset backed and project-financing approach to help hedging risks

As a result, the lessons from the crisis;

– Islamic banking is inherently stable

– Islamic banks outperformed the conventional financial institutions

Agenda








Q&A

What is Sukuk?

“What Does Sukuk Mean?

An Islamic financial certificate, similar to a bond in Western finance, that complies with Sharia, Islamic religious law. Because the traditional Western interest paying bond structure is not permissible, the issuer of a sukuk sells an investor group the certificate, who then rents it back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the bonds at a future date at par value.

Source: Investopedia.com

What is Sukuk?

“Sukuk”s are (as per AAOIFI definition):

– Certificates of equal value

– Representing undivided shares in ownership

– Of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity

What is Sukuk?

“Sukuk”s equate to ‘certificate of entitlement’

Generically, viewed as an Islamic equivalent to a conventional bond

Better described as an asset-based investment

Evidences the holder’s ownership in underlying assets and a clear link with the asset

Underlying assets are typically segregated into a special purpose vehicle (SPV)

What is Sukuk?

Gives entitlement to returns generated from the assets

Rank pari-passu with other senior obligations of the obligor

Can be listed or unlisted, rated or unrated

Can have a fixed pricing or a floating rate benchmarked against an index (LIBOR etc.)

Is it a “Bond” ?

A “BOND” is a certificate of debt under which the issuer agrees to pay interest (if any) and to repay the principal to the bondholder on specified dates.

SUKUK

– Economic characteristics has similarities to that of a conventional bond

– Key difference : Sukuk is not a debt instrument. It represents a proportionate beneficial ownership in the underlying asset, giving the holder the right to the benefits of the income stream of the underlying asset. The yield is usually linked to a return on an underlying asset through an Islamic structure e.g. lease. It is priced, listed and rated as a bond, although it is more akin to a participation in a collective investment scheme.

Islamic Finance: Relevance and Growth in the Modern Financial Age | 18

Is it a “Bond” ?

SUKUK BONDS

Nature Not a debt but undivided ownership share or rights in specific assets/projects/services

Debt of Issuer

Asset Backed A minimum of 51% Tangible Assets (or their contracts are required back issuance of Sukuk al Ijara)

Not required

Claims Ownership claims on the specific underlying assets, project, service etc.

Creditors claims on the borrowing entity, and in some cases liens on assets.

Security Secured by Ownership rights in the underlying assets or projects in addition to any additional collateral enhancements structured

Generally unsecured debentures except in cases such as first mortgage bonds, equipment trust certificates and so on

Principal and Return Not guaranteed by Issuer Guaranteed by Issuer

Purpose Must be issued only for Islamically permissible purposes Can be issued for any purpose

Responsibility of Holders

Responsibility for defining duties relating to the underlying assets/projects limited to the extent of participation in the issue.

Bondholders have no responsibility for the circumstance of the issuer

AAOIFI has specified certain categories of permissible sukuk.

Categories of Permissible Sukuk

Agenda








Q&A

Sukuk Market

• In 2010, the primary sukuk market expanded by 50.9% yoy with new issuances touching an all-time high of US$ 50.5 Bn, beating 2007’s record of US$ 38.2 Bn

• 1H10 witnessed new sukuk issues totalling US$ 9.7 Bn, an increase of 157.5 % over US$ 7.6 Bn in 1H09

• 2H10 saw new sukuk issues almost doubled to US$ 30.8 Bn, rising by 65.2 % over US$ 18.6 Bn in 2H09

• Sukuk issuance in the subsequent nine months of 2010 was boosted by sovereigns, which dominated 69.9 % of total Sukuk issuances in 2010

• This was followed by financial institutions at 11.5 % and infrastructure (construction, power & utilities) at 9.8 %

• The leading sovereign issuer was Bank Negara Malaysia as well as the governments of Indonesia, Qatar, Pakistan and Bahrain

Source: Central banks, IFSB, Zawya, KFHR

Sukuk Market

0

10000

20000

30000

40000

50000

60000

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

E

USD m

ln

• Drivers of the primary sukuk market in 2010 were the financing needs of governments, implementation of infrastructure projects to boost economic growth, the need of working capital for businesses in line with global economic recovery as well as financial institutions capital raising activities.

Sukuk issuance trend (2000-2010) Quarterly Sukuk issuance (2008-2010)

02000400060008000

1000012000140001600018000

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

USD m

ln

Other

Mena

Source: Central banks, IFSB, Zawya, KFHR

Sukuk Market At a Glance

Sukuk issued by sector (2010) Sukuk issued by country (2010)

Sukuk issued by currency (2010) Top 10 sukuk deals by value & country (2010)

0 5000 10000 15000 20000 25000 30000 35000

ManufacturingOil & gasServices

AgricultureConstruction

Real estateTransport

TelecomPower & utilities

Financial servicesSovereigns

USD Mn0 5000 10000 15000 20000 25000 30000 35000 40000

MalaysiaIndonesia

SaudiQatar

PakistanUAE

BahrainBruneiJapan

TurkeySpore

GambiaUK

USD Mn

0 5000 10000 15000 20000 25000 30000 35000

GBPGMDBNDBHDPKRSGDQARUSDSARIDR

MYR

USD Mn

Country No. of deals Amount USD Mn

Malaysia 6 5,732

Saudi Arabia 1 1,867

Qatar 1 1,374

Indonesia 2 1,351

Total 10 10,324

Malaysia continued to dominate and lead the primary sukuk market in 2010 (75.1%)

Sukuk deals were mostly Ringgit denominated (70.3%)

Sovereign issues dominated the primary sukuk market in 2010 (69.9%), led by Malaysia central bank

Sukuk Market Outlook 2011

• Based on the issuance momentum seen in 2010, the global sukuk issuance in 2011 is expected to remain high at US$ 35 Bn – US$ 40 Bn, characterized by the following:

• 2011 Sukuk market is driven by the recovery in global economic activities, still accommodative monetary policies with gradual interest rates hikes, continued sovereign fund raising to support economic growth as well as revival of private sector projects. This will ensure the revival of infrastructure projects on both the conventional and Islamic capital markets

• More sovereign issuers are anticipated to tap the sukuk market moving forward as governments will continue to raise funds to support economic growth and fund fiscal deficits

• New emerging market players as well as new non-Islamic issuers are expected to tap the Sukuk market with potential debuts from Thailand, Japan, Russia and Europe

Sukuk Market Outlook 2011

• Increasing demand and popularity for Sharia compliant products and structures post the global financial crisis will form a strong demand base for Sukuk.

• Initiatives taken by various jurisdictions in developing legislative and regulatory frameworks, as part of efforts to attract foreign investments, would allow these new players to explore the Sukuk industry for the first time. This could also prompt other new jurisdictions to follow suit.

• Ijara structure will continue to dominate the market.

Agenda








Q&A

• Sovereign

• Financial Institutions

• Corporates

Issuers’ Perspective

Sovereign Sukuk

Suitable instrument for Treasuries to attract global investors

Provides diversification of investor base and instruments

May be utilised to achieve long-term funding for infrastructure projects

Sets benchmark for the FI and corporate issuances

–Malaysian Ijara Sukuk (2002)

–German State of Saxony - €100 million Ijara Sukuk (2004)

–Qatar – US$700 million Ijara Sukuk (2005)

–Bahrain - Several sukuk issuances (Ijara and Salam) since 2003

–Pakistan – US$600 million Ijara sukuk to finance the Lahore to Islamabad motorway (2005)

–Dubai Metals and Commodities Centre – Quasi-government US$200 million Musharaka Sukuk (2007)

–Indonesia – IDR 4.7 Trillion debut Rupee Musharaka Sukuk (2008)

–Sovereign initiatives are in existence throughout the globe (U.K., Turkey etc.)

Selected Sovereign Transactions

Sovereign Sukuk- Developments

Has long been discussed on “Non-technical” terms

Regulatory problems have not been revisited in some jurisdictions (i.e. taxation)

Very attractive with its booming size and global coverage

• Sovereign


• Corporates


FI Sukuk Issuance

A long-term funding instrument to support balance sheet growth and maturity mismatch for Islamic banks

Classical problem for Islamic Fıs : A considerable portion of their assets are allocated to non-tradable short-term investments.

This adversely impacts yields and asset diversification

FIs may issue Sukuks to fund their balance sheet in order to support their growth and become more competitive

If sovereigns issue Sukuks, Islamic Fıs may place their excess liquidty to these instruments, which then can be utilised for short-term funding (repo-like) instruments with Central Banks

Selected Recent FI Transactions

Issue Date Issuer Rating

Currency

Amount Maturity Coupon

17-Aug-10 Kuveyt Turk Katılım Bankası AS

BBB- USD 100,000,000 3 5.25

30-Sep-10 Qatar Islamıc Bank SAQ-QIB

A USD 750,000,000 5 3.856

20-Oct-10 Islamic Development Bank

AAA USD 500,000,000 5 1.775

28-Oct-10 Abu Dhabi Islamic Bank PJSC

A+ USD 750,000,000 5 3.745

18-May-11 Islamic Development Bank

AAA USD 750,000,000 5 2.35

18-May-11 Sharjah Islamic Bank BBB+ USD 400,000,000 5 4.715

26-May-11 HSBC Bank Middle East Ltd

A1/AA-

USD 500,000,000 5 3.575

Why Sukuk is critical for Islamic Banks?

Excess Liquidity in the Market, resulting in serious business risk and affects the competitiveness of IFIs due to no return or a very

low returns.

In a recent study it was discovered that Islamic financial institutions are almost 50% more liquid as compared to

conventional financial institutions.

Out of US$ 13.6 billion total assets of Islamic banks in the study US$ 6.3 billion were found to be in liquid assets.

Liquidity Risk: Definition

Risk of Funding [at appropriate maturities and rates]

Risk of Liquidating Assets [in time at reasonable prices]

Key Issues in Liquidity

Management

Small No. of participants

No Islamic Inter-bank Market

Slow DevelopmentInIslamic financial Instruments

Absence of Islamic Secondary market

No Lenderof LastResort

Different Shari’a interpretation

Key Issues in Liquidity Management

Credit for this diagram: IIFM

Implications for Islamic Banks

Underutilization of financial resources

Lower income and higher cost

Loss of competitiveness

• Sovereign


• Corporates


Corporate Sukuk Issuance

A long-term funding instrument to support their growth

Access to various new markets and new investors

Diversification

May have more paperwork and structuring costs

Selected Corporate Transactions

–Bahrain Financial Harbour – US$270 million Istisna’a/Ijara project finance Sukuk (2005)

–Nakheel – US$3.52 billion project finance Ijara Sukuk (2006)

–DP World – US$1.5 billion Musharaka Sukuk (2007)

–Gulf Finance House – US$1 billion Sukuk MTN (2007)

–Aldar Properties – Equity Linked US$2.53 Mudaraba Sukuk (2007)

– Tamweel – US$210 million Ijara Sukuk (2007)

Agenda








Q&A

Sukuk Ijara

The first Islamic fixed-income instrument or Islamic security accepted by the global market

This structure is based on sale and lease back concept.

Sukuk Ijarah represents an individed and proportionate beneficial ownership of the leased assets.

Sukuk Ijarah is permissible for secondary market transactions.

The structure of sukuk Ijarah allows the rental payment to be fixed or floating based on a benchmark that is revised before the commencement of a rental period. The benchmark is merely a reference point to decide the cost of the fund upon which the new rental will be based.

Sukuk holders

Issuer SPV (orphan)

Obligor

obligor

(6) Periodic payments/

redemption amount

(1) Issue Proceeds

(5) Rentals

(4) Lease

(3) Sale of asset to issuer SPV

(2) Proceeds

(7) Service agency

(8) Purchase undertaking- redemption and acceleration

Sukuk Ijara

Sukuk Musharakah

Sukuk Musharakah is similar to Sukuk Mudarabah as both are equity-based contracts. However, some features are unique to a Musharakah contract. These include:

- Both parties to a Musharakah contract must contribute the capital into the business venture

- While a PSR can be negotiated, loss sharing must be proportionate to capital contribution

- Both parties have the right to participate in the management of the business venture

Sukuk Musharakah

In Sukuk Musharakah both the company and investors contribute their respective capital in an identified business venture.

The capital could be in the form of cash or kind.

The profit, if any, will be distributed between the investors and the company according to an agreed PSR.

Investors would expect to receive the estimated periodic profit distribution, as Sukuk are deemed to behave like fixed-income instruments.

There is no obligation on any party to pay a fixed amount by way of income or profit and there is no guarantee on the capital invested.

Obligor’s Purchase Undertaking

Obligor’s capital contribution

Musharaka

Issuer/Trustee Obligor

Issuer/Trustee

Sukuk holders

Periodic DistributionA

mounts

Dissolution Distribution Amount

proceeds Sukuk

proceeds

Exercise PriceSale of ‘units’

Sukuk Musharaka

Sukuk Mudarabah (1/2)

Mudarabah is a partnership contract whereby one party provides the capital and other provides the management and entrepreneurship skills.

For a Sukuk structure to raise the necessary capital, the capital providers will be the investors, the issuer will be the company and manager (Mudarib) who will manage the business venture. The other features of a Mudarabah contract include :

a.Neither the capital nor the profit is guaranteed

b.The manager (Mudarib) will not be liable for the loss, unless it is caused by his negligence and misconduct.

c. The Profit Sharing Ratio(PSR) can be revised with the consent of both parties.

d.The capital providers may agree to limit the rate of return whereby the remainder can be given to the manager as an incentive or performance fee.

Sukuk Mudarabah (2/2)

In practice, the company may issue the Sukuk directly or set up a Special Purpose Vehicle (SPV), being a remote entity, to issue Sukuk Mudarabah to facilitate the partnership between the investors and the manager.

Normally an SPV is a trust company and all the assets it holds are for the benefit of the Sukuk investors. The creditors of the issuer cannot serve any liquidation order on this entity. The incorporation of the SPV is to protect the interest of the Sukuk holders.

The proceeds of a Sukuk Mudarabah subscription will be used to finance the business activities in the identified venture.

The profit, if any, is based on a ratio or percentage, such as 1/3:2/3 or 30%:70%, investors may agree to cap their profit to, for example, 10% of the capital. The remainder will be waived and given to the manager as a performance fee.

OBLIGOR(as Mudarib)

MudarabahAgreement

Issuer/Trustee/Rab al-Maal

Sukukholders

Periodic Distribution Amounts

Proceeds

Periodic Distribution Amounts

Dissolution Distribution Amount

Proceeds

Sukuk

OBLIGOR

Mudarabah Assets

Purchase Undertaking

Sukuk al-Mudarabah

Asset Based Portfolio Based

Source: The International Islamic Financial Markets Conference 2005 (Bahrain), Morgan Stanley Research

Sukuk: Secondary Markets

Sukuk Secondary Market

Sukuks may be listed in Stock Exchanges and can be traded, which is essential for liquidity purposes

Active secondary markets attract more investors as most of them do not prefer to purchase such securities to hold, but rather for sale purposes

Conventional bond market is very active in terms of secondary trading and the turnover is huge

Structures and documentation should be standardised to enable Sukuks to be traded in several global jurisdictions

Agenda








Q&A

Turkish Economy

Real GDP Growth

• One of the largest economies in the region

• Country is well placed to attract foreign investment geared for domestic demand and exports to its neighbours, including Middle East

• The Turkish banking system is in strong position to face an environment of tighter regulation less reliance on cross border flows and low loans to deposit ratio

• Household sector is not leveraged• Public sector debt is low and not subject to FX risk• Banks are well capitalized with low external financing needs

• Growth strong sustainable growth– 2011 GDP recorded 11.0% growth in Q1 and 8.8% growth in Q2

• Over performance in the budget – Budget deficit declined to 3.6% of GDP in 2010 from 5.5% in 2009– 2011 planned deficit is expected to be 2.8% of GDP

• Turkey’s sovereign risk profile looks more favorable vs. decreasing trend in the sovereign risks of developed countries– S&P – BB (upgraded in Feb 2010)– Moody’s – Ba2 (upgraded in Jan 2010)– Fitch – BB+ (kept in Nov 2010)

Economic and Financial Activities

Indicator 2007 2008 2009 2010

Nominal GDP (USD billion) 649 742 617 736

GDP Per Capita (USD, thousands)

9 10 9 10

Population (million) 71 72 73 74

CPI % (YoY) 8 10 7 6

Interest Rate (CBT O/N Borrowing, EOP)

15.75 15.00 6.50 1.50

TRY/USD(EOP) 1.16 1.52 1.49 1.54

TRY/EUR (EOP) 1.71 2.13 2.14 2.05

Unemployment % 10 11 14 12

Current Account (USD billion) (38) (42) (14) (48)

% of GDP (6) (6) (2) (7)

Trade Balance (USD billion) (47) (53) (25) (57)

Source: TURKSTAT, OVP

EOP: End of Period

Banking Sector Overview

No. of Banks No. of Branches

Deposit Banks 31 9,539

Public Banks 3 2,793

Private Banks 11 4,896

Saving Deposit Insurance Fund 1 1

Foreign Banks 16 1,849

Development and Inv. Banks 13 42

Participation Banks 4 631

Total 48 10,212

2011 Q1 Banking Sector Parameters

Key Financial Indicators (USD million) Key Financial Ratios (%)

Source: BRSA – Banking Regulation and Supervision Agency Applying TL to US$ conversion rate of 1:0.660 and 1:0.599 for 1Q2009 and 1Q2010, respectively.

2010 Q1 2011 Q1 % Change

Total Assets 568,054 682,045 20

Securities Portfolio 182,094 181,519 0

Loans 275,120 367,910 34

Non-performing Loans 13,855 12,329 -11

Deposits 352,312 410,237 16

Equity 77,192 87,945 14

Net Income (Loss) 3,959 3,569 -10

2010 Q1 2011 Q1

Loans/Total Assets 48 54

Deposits/Total Assets 62 60

Loans/Deposits 78 90

NPL 4.89 3.24

CAR 19.95 17.97

4.0 5.1 7.3 9.9 13.719.4

25.833.6

43.3

1.83%2.01% 2.33% 2.44%

2.75%

3.35% 3.52% 4.03%4.31%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

2002 2003 2004 2005 2006 2007 2008 2009 2010

3.2 4.1 6.0 8.411.2

14.919.2

26.8

33.2

2.20%2.49% 2.95% 3.19% 3.47%

4.02% 4.06%5.22% 5.36%

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

-5.0

5.0

15.0

25.0

35.0

45.0

55.0

2002 2003 2004 2005 2006 2007 2008 2009 2010

2.1 3.0 4.9 7.410.5

15.319.7

24.9

32.2

3.83%4.16%

4.55% 4.63% 4.60%

5.22% 5.13%5.95% 5.83%

22.533.544.555.566.57

0

10

20

30

40

50

60

2002 2003 2004 2005 2006 2007 2008 2009 2010

Participation Banking

Ample Room for Growth Participation Banks’ Asset Size (TL billion) and Market Share Development in Turkey

• Prior to 2005, Banks operating under interest-free (Islamic) banking principles were named “Special Finance Houses”. In November 2005, the Banking Law No.5411 was put in place and “Special Finance Houses” label has been transformed into “Participation Banks”, gaining the “bank” status

• Today, Participation banks are subject to Banking Law of Turkey and supervised by Banking Regulation and Supervision Agency (“BRSA”) like any other conventional banks in Turkey

• Market share of participation banks in Turkey has been constantly increasing

• As of today, there are only four participation banks operating in Turkey – one being Kuveyt Turk

Total Participation Banks Loans (TL billion) and Market Share Development in Turkey

Total Participation Banks Deposits (TL billion) and Market Share Development in Turkey

Source: PBAT – The Participation Banks Association of Turkey.

CAGR: 40.7% CAGR: 34.0%

CAGR: 34.7%

Case Study : Kuveyt Turk Sukuk

Sukuk in Turkish market has long been discussed on the basis of a sovereign issuance

Problems existed on several aspects (taxation, accounting, documentation etc.) as Turkish regulatory framework did not define “Sukuk” as a financial instrument

Lack of a long-term funding instrument posed a problem for future growth prospects of Islamic banks in Turkey

Kuveyt Turk succeeded in structuring a Sukuk within the framework of existing regulations based on a Wakale structure

Case Study : Kuveyt Turk Sukuk

Most Innovative Deal

KTPB Sukuk

The issuance has been based on Wakale/Ijarah structure

Included Ijara assets and murabaha receivables

Listed in London Stock Exchange

3-year maturity and an amount of USD 100 million

Rated BBB- (investment grade) by Fitch

First and only FI Sukuk issuance in Turkey and Europe

Kuveyt Turk Sukuk Structure

Description:

1-SPV declares a trust in favor of investors2-Investors subscribe to the Sukuk and fund the SPV3-KT will, on inception date, sell a portfolio of assets (consisting of a minimum of%51 Ijara assets) to the SPV. It will periodically sell additional assets to the SPV as the original portfolio amortizes. The portfolio must be identified and the sale will be reflected in the records of the bank4-The SPV appoints KT as its Agent (or Wakil) to make collections from Customers5-The Wakil collects rents and installments from Customers6-The Wakil distributes collections to the SPV.The SPV will (i) distribute periodic distributions to Sukuk holders (Step 9); (ii) use any amortization amounts to purchase additional assets (always maintaining minimum 51% ljara content in the underlying portfolio); (iii) any excess will be kept in notional reserve account with KT7-KT provides an undertaking to purchase the portfolio at maturity of the Sukuk for an amount equal to the unamortized value of the portfolio (which will always equal 100 as amortized amounts are reinvested)8-The SPV will periodically distribute profits to Investors, and at maturity will distribute the principal amount of the Sukuk to Investors. If there is a positive balance in the reserve account, KT shall keep the excess as an incentive fee.

New Sukuk Regulation: Rental Certificates

Capital Markets Board (Turkey) issued a Communique on 1st April 2010 called “Rental Certificates”

Based on Sukuk Ijara structure

Enables financial institutions and corporates to issue Sukuk within Turkey and/or abroad

Tax exemptions provided as of January 2011 by law (in line with conventional bonds)

Issuances under this scheme are expected to be realised till year-end 2011

Turkish Rental Certificates

Public Certificate holders

Asset Rental Company

Originator

Originator

(6) Periodic payments/

redemption amount

(1) Issue Proceeds

(5) Rentals

(4) Lease

(3) Sale of underlying asset

(2) Proceeds

(7) Service agency

(8) Purchase undertaking- redemption and acceleration

Agenda








Q&A


Standardisation of structures and documents are critical

Regulatory classification of Sukuk in various jurisdictions expected to support growth

Sovereign issuances expected to pave the way and set the benchmark for FI& corporate issuances

Secondary market tradability to improve

AS A CONCLUSION :

CHALLENGES ARE THERE,

BUT THE FUTURE SEEMS BRIGHT!

Agenda








Q&A

Thank you

Reşid ÇizmeciInvestment Banking, Kuwait Turkish Participation Bank

k uwait t urk investment banking and sukuk : an introduction to islamic capital markets

Documents

islamic bankingmalaysia

islamic financeuk

islamic retail market

islamic bankingsukuk

islamic finance markets

global corporates

kuwait turk investment

new markets